Eastman Chemical Company (NYSE:EMN) – A Stock To Avoid

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At The Applied Finance Group’s (AFG’s) client conference this year we introduced a new session called “10 Stocks To Avoid” to provide some actionable ideas to attendees of the conference. So far this portfolio is performing as expected with many of the stocks we recommended avoiding down more than their benchmarks since the conference on June 11, 2010.

One of the stocks we recommended avoiding is Eastman Chemical Company (NYSE:EMN) as it looks unattractive according to several criteria AFG uses in its stock selection process.

As you will see in the charts below EMN has not been earning its cost of capital in the last sixteen years, represented by the negative EM levels in the first chart. Additionally, its stock price looks expensive relative to AFG’s default intrinsic value for the stock. All of these factors caused us to label the company one to avoid. Since the conference, Eastman Chemical Company (NYSE:EMN) is down over 8% while the S&P 500 is down just 2% (seen in price chart below).

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Below you will find AFG’s Wealth Creation Report which will illustrate EMN’s management’s inability to create wealth for its shareholders, EMN’s intrinsic value chart which shows EMN currently trading at a premium to its default intrinsic value and a few reasons why we believe the company will struggle. Also showed at the bottom of the article is EMN’s performance relative to its S&P 500 benchmark since we recommended avoiding EMN at our conference.

EMN Description:

Eastman Chemical Company is a diversified chemical company which manufactures and sells a broad portfolio of chemicals, plastics, and fibers. The Company operates in five business segments including the Coatings, Adhesives, Specialty Polymers, and Inks (CASPI) segment, the Fibers segment, the Performance Chemicals and Intermediates (PCI) segment, the Performance Polymers segment, and the Specialty Plastics segment. Headquartered in Kingsport, Tennessee, EMN has eleven manufacturing sites across the U.S., Europe and Asia-Pacific, supplying products throughout the world.

We believe EMN is currently overvalued and will underperform the market for the following reasons:

1. EMN recently reported encouraging Q1 results as revenue soared 39% and profits jumped from $2 million to $101 million, helped by very easy comparisons. However, a sustainable recovery towards pre-recession levels remains uncertain. The chemical industry is heavily exposed to economic cycles and the recent recession has significantly weakened the demand for chemicals, which resulted in lower capacity utilization and higher unit production costs. Demand remains particularly weak given lower production levels in key customer industries including residential and commercial construction, automotive, electric and furniture. In addition, the recent sovereign debt crisis in Europe could materially impact the economic recovery in the region which EMN has a big exposure to.

2. EMN is exploiting business restructuring and cost-cutting measures to offset higher fixed operating costs and declining earnings. As part of its restructuring effort, the company sold or closed unprofitable businesses across the world. Nevertheless, high raw material and energy costs remain a concern for chemical producing companies, and management expects volatility in input costs to continue. Oil price currently trades above $70 per barrel, hovering at the 2007 price levels.

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